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How did a small Northland town's sewerage scheme blow up into an $80 million financial and legal disaster? As residents await an Auditor-General's inquiry into the fiasco, Andrew Laxon reports on the topsy-turvy world of Kaipara District Council

In Mangawhai, hundreds of otherwise law-abiding home owners have been on a rates strike for more than a year. Some compare their plight to Alice in Wonderland - expected to pay illegal rates which are about to become officially legal, set by a renegade council which essentially made up the rules as it went along. Many are members of the Mangawhai Ratepayers and Residents Association (MRRA), which claims Parliament is getting ahead of the courts and the Government's watchdog, the Auditor-General, in its attempts to clean up the mess. To make matters worse, the Auditor-General, whose inquiry will be made public this week, is directly responsible for the auditors, who were supposed to keep watch on the council.

The rates strikers are outspoken and tend to divide local opinion. Some Kaipara people portray them as a bunch of rich, whinging Aucklanders but even their biggest critics concede that their determination has forced reluctant politicians and officials to act. So, ahead of the official findings on Tuesday, here is what we already know from council, court and parliamentary records about what went wrong - and why not everyone is likely to be satisfied.

What is the inquiry about?

In 2006, Kaipara District Council secretly changed its plans for a sewerage scheme for the Mangawhai harbour, increasing the cost from $35.6 million to $53 million without telling ratepayers. It kept the true cost off its books for five years but most ratepayers only realised the scale of the debt in April last year when the council suddenly increased rates by an average 31 per cent across the district and several hundred per cent for some properties in Mangawhai.

A simmering rates strike boiled over, the council was forced to step down after a ministerial review team slammed their incompetence and commissioners were appointed to run the district. Meanwhile Mangawhai ratepayer and retired lawyer Clive Boonham discovered that the council had also illegally set $17 million in rates. Total borrowing hit $80 million, including $62 million for the sewerage scheme, partly because the council was adding unpaid interest payments to the loan.

The Auditor-General announced an inquiry into the cost blowout for the Mangawhai sewerage scheme, which was supposed to be finished by the end of last year.

Why has it taken so long?

One interpretation is the region's problems have turned out to be deeper and more complex than most outsiders imagined. The commissioners say the disastrous sewerage scheme is just "the tip of the iceberg" in a council with a history of "systemic inadequate performance". Several MPs have questioned in Parliament whether the council's problems go beyond mere incompetence. However, Auditor-General Lynn Provost has already advised her report will not lead to criminal charges against anyone. A more cynical view from Mangawhai Ratepayers and Residents Association chairman Bruce Rogan is that the year-long delay is a tactic designed to kill off his rates strike, which has grown to more than 1000 ratepayers withholding $3.8 million or 12.5 per cent of the council's rates. The commissioners, led by former National MP John Robertson, have persuaded Northland MP Mike Sabin to sponsor a bill which will make all the illegally set rates legal. The bill also cuts across an MRRA High Court bid to have the rates declared illegal, which the council's own legal advice says would be likely to succeed.

Why didn't Parliament wait for the court case and the Auditor-General's report?

Sabin says Parliament had to act because the strike is costing up to $400,000 a month and the district is missing out on millions for road improvements. He says it's coincidence that the bill becomes law the day before the report is released, as the report was supposed to have come out a month ago. The rates strikers have also won a small concession, persuading MPs to throw out any late payment penalties on the illegally set rates.

But MRRA lawyer Matthew Palmer told the select committee that Parliament should not validate those rates which remained clearly illegal. In particular, ratepayers were charged in 2008 and 2009 for services that did not exist at the time and the council invented a "unit of demand" which charged extra for sheds and sleepouts, contrary to the law.

So who's to blame?

Most critics have highlighted the prominent role of former chief executive, Jack McKerchar, who resigned in October 2011 with a $240,000 severance payment that remained secret for 15 months. Former councillor Bill Guest unsuccessfully tried to force McKerchar's resignation in March 2010, complaining to the council that McKerchar refused to provide vital financial and legal information and that debt and spending on consultants had risen unchecked under his watch.

NZ First MP and former North Shore mayor Andrew Williams told Parliament he was appalled to learn that councillors did not receive quarterly financial reports and were "denied that information by the chief executive officer and the council" when they asked for it. Sabin told MPs there were huge questions over "the operating relationship between the former chief executive officer Jack McKerchar and the elected members of this council, the due diligence processes, and the relationship between Mr McKerchar and consultants and contractors." McKerchar has declined to speak to the Herald until the Auditor-General's report is made public, citing legal advice. In 2010 he responded to Guest's criticism in a memo to councillors which said, "My public credibility is being destroyed yet there is no basis for the claims being made."

Shouldn't the council be held responsible for its bad decisions?

The review team, led by former Fonterra board member and Ruawai dairy farmer Greg Gent, made this point. Their report said councillors complained that McKerchar was "very judicious" in giving out information but it was their responsibility to get it. The review found that councillors could not have carried out their duties on the level of financial information they received and concluded there had been a breakdown of trust between the mayor and councillors and the community, which required the removal of the entire council. During the passage of the bill, Boonham, Sabin and Williams also questioned the role of consultants and advisers, who allowed the expanded scheme to go ahead.

Williams told Parliament: "In my experience of local government, there will be some professionals involved in this who should certainly be accountable for their actions, because they have very, very badly informed the council there. They have provided information that has blown out by tens of millions of dollars, and, at the end of the day, It actually states that it does not really matter, if one works at the council, because the council can do anything it likes, really ... This is fraudulent legislation. The only people who are accountable are we poor people who have to pay the rates.Judith Collins opposing the guarantee on council loans in 2002somebody should be accountable for this."

In his submission, Boonham argued that banks and lawyers had relaxed their normal standards of due diligence because of a 2002 law change, which guaranteed loans made to councils even if they later turned out to be illegal.

Doesn't that let councils and banks off the hook?

That's what current Justice Minister Judith Collins argued in opposing the former Labour Government's broadening of council powers under the Local Government Act. Collins told Parliament in 2002 that the so-called "protected transactions" clause which guaranteed the loans made a mockery of council accountability. In a speech viewed as prophetic by many Mangawhai ratepayers, she said, "It actually states that it does not really matter, if one works at the council, because the council can do anything it likes, really ... This is fraudulent legislation. The only people who are accountable are we poor people who have to pay the rates." National takes a different view now. Sabin says removing the protection for banks would force up interest rates for all councils as banks price in the increased risk, leading to unnecessary rate increases across the country.

Why did the council's auditors not see what was happening?

Residents and MPs alike have expressed disbelief at the failure of Audit NZ to act. In Parliament Sabin questioned how the council could get clean audits year after year as cost of the scheme increased from $11 million to $62 million without proper ratepayer consultation. He said there were major inconsistencies that should have been obvious between the financial projections in the council's long term plan and the funding arrangements for the sewerage scheme. "How could Audit New Zealand also sign off on the long-term council community plan that relied heavily on the collection of development contributions (payments to council by property developers for services such as sewerage and roads), when there were no development contribution policies in the plan? Similarly, the long-term council community plan was signed off, when the rates needed to fund the Mangawhai waste-water scheme were not even included in the funding impact statement that is critical to the council being able to set the rate."

A 2011 financial health and sustainability audit by PJ & Associates observed that Audit NZ gave the council's long term plan an unqualified audit opinion, meaning it complied with all statutory requirements, despite the plan disclosing operating deficits in 2011/12 and 2015/16 in breach of the Local Government Act. Noting this finding, the review team recommended the commissioners seek legal advice on the perceived failures of the auditors. The review team also questioned whether the auditors should have spotted the invalid rates, lack of a clear development contributions policy and internal borrowings (money supposedly set aside for specific purposes such as conservation but not accounted for).

A former financial consultant to the council, Larry Mitchell, told the select committee he believed the auditors had defaulted on their basic duties by missing about $25 million of debt for unauthorised borrowings on the sewerage scheme. He called for a "truly independent investigation", saying the Auditor-General's inquiry was fundamentally flawed through conflict of interest.

How can the auditors investigate themselves?

Auditing and Assurance Standards Board chairman Neil Cherry has conducted a separate investigation into Audit New Zealand's role, to be released with the main report this week. Sabin hopes that if it finds Audit NZ was clearly at fault, Auditor-General Lynn Provost will accept liability for about $30 million of debt incurred by the sewerage scheme cost overrun - effectively asking taxpayers to subsidise Kaipara ratepayers, on the grounds that the council raised the debt illegally and without their consent. His bid would probably require Cabinet support to succeed.

What else did the council do wrong?

Council documents presented to the select committee by Bill Guest show he repeatedly - and unsuccessfully - raised concerns about the council's spending on consultants. Instead of updating its district plan, the council rewrote it completely and hired consultants. The cost soared from the original contract of $430,000 in 2005 to $3 million in 2011. An Audit Office review found one payment of $319,000 in 2009 for which it could not identify a signed contract. Guest says the final cost after eight years and countless delays was about $6 million.

The council also contracted out resource consents and roading work. It agreed on one three-year contract for $6 million between 2007 and 2009 but paid out $14,785,427 over the same period. Guest says the final bill was $17 million, which would have paid for 50 well-qualified staff earning more than $100,000 a year.

Did residents get good services for all this money?

Unfortunately, Kaipara's performance levels were among the worst in the country. In 2007 a Ministry of Environment survey found it was New Zealand's slowest council for resource consents, processing less than a quarter on time. The review team said the New Zealand Transport Agency rated Kaipara's roads as one out of five, the first time a council had received such a low score. A confidential draft review of the council's core business services by Executive Management Consultancy - ordered by McKerchar but never shown to councillors - said a large number of residents found the council responded to their problems either slowly or not at all. Staff described procedures for sewer and storm water as "chaos" and accounts as "very antiquated". It concluded, "In discussions with virtually all staff in this current assesment there is recognition of blockages in the internal systems, unallocated accountabilities, no established processes, processes not understood or not followed and lack of coherency in some of the internal workings of council."

So many residents won't be surprised it ended up like this?

Former deputy mayor Peter Bull, who left the council in 1998, says the Dargaville swimming pool is a prime example of the poor spending controls and lack of consultation that led to the Mangawhai blowout. He says the pool was originally meant to be 30m long and cost $3 million, according to the council's long term plan. "They went ahead and built a $6 million pool 50m long without any consultation through the annual plan or long term plan. It's costing a fortune. Over 1 per cent of the total general rate take is going in a a grant to keep that pool open - over a quarter of a million dollars." The old council defended the pool as a great community asset but the new leadership takes a different view. Current chief executive Steve Ruru, who replaced Jack McKerchar, said in an August report that the council needed to address a number of medium-term risk issues, including no formal agreement covering the use of the land and the operating trust's heavy reliance on the council for funding.

Is the council financially secure?

The council's new auditors, Deloittes, have described its heavy reliance on future property growth at Mangawhai to pay off the debt as "a significant forecasting assumption". Mangawhai home owner and local government specialist Joel Cayford calls it completely unrealistic, as the forecasts rely on $600,000 a year from developers for the next 10 years, rising to $1 million a year for 20 years after that. Yet the council received only $100,000 this year and the Government plans to clamp down on heavy use of these charges in future. Development in Mangawhai also remains badly affected by the coastal property slump and the sewerage scheme debacle.

A local property report by economist Rodney Dickens last year found enough houses for sale to meet 2.3 years of demand, "enough above the national average of six months to ring warning bells".